Given the multitude of world records this region aspires to add to its roster of achievements, Saudi Arabia managed to pull off the world's largest initial public offering (IPO) in history, raising $25.6 billion from its crown jewel asset Saudi Aramco. The Saudis sold 1.5% of the company via 3 billion shares at 32 riyals ($8.53) and has successfully beaten the 2014 public debut of Alibaba Group Holding (BABA) .
The IPO valued Saudi Aramco at $1.7 trillion, below the aspired level of $2 trillion targeted over the past few years. However, in light of substantially lower oil prices, this was inevitable. Depending on where the stock price opens for business this Wednesday, Dec. 11, Saudi Aramco could decide to exercise the overallotment option to bring the final IPO total to $29.4 billion.
This IPO is an important milestone that will help the country to diversify out of oil and embark on its Vision 2030 plans for the future. The issue was limited to floating on the Saudi local exchange, Tadawul, as there was little international interest despite various attempts. The issue was subscribed mostly by local Saudis, a few sovereign wealth funds in the region and China, the intention of which can be seen to be more strategic than fundamental. As a U.S.-China trade deal is far from materializing, it is in China's interest to diversify its oil imports from other regions to the detriment of the U.S.
The OPEC meeting this past weekend could not have come at a better time. Saudi Arabia had one agenda in mind: keep in place the production cuts of 1.2 million to 1.5 million barrel per day from 2017. After the floating of Saudi Aramco, keeping production in check was of even more importance as the IPO cannot be seen as failing. The whispers not only were to keep production in place but to suggest even deeper cuts of up to 500,000 barrels per day. At a time when the U.S.-China trade war has exacerbated the global economic slowdown and demand for oil falters amid a growing surplus of inventory, this was an easy sell as producers do not want to see prices dip below $55 a barrel for Brent crude.
The cuts would be in place through first quarter of 2020 and would only be implemented if all countries complied. Also, Russian Minister of Energy Alexander Novak said condensates no longer would fall in this category of "cuts," implying the total cuts to be less than read at the onset. The most important point to note is that no one was actually complying with their current quotas prior to this meeting, so to throw out a number of 500,000 barrels per day is futile.
Saudi Arabia has been producing a lot less than its quota over the past few months. If you do the math, this "deep cut" is really nothing more than cementing what was already happening in the market. At best, it potentially removes 200,000 barrel per day from the market. These OPEC meetings are more to announce and make official what already has been agreed to or is already in place. Other than yet another sensationalized media event, it is nothing more.
Forgetting the OPEC and Aramco noise, let's see what is happening behind the scenes that can have a much bigger impact on Aramco and the oil market itself. In less than a year, central banks around the world have moved from quantitative tightening (QT) to quantitative easing (QE). In 2018, we saw a net 42 rate hikes and $650 billion in liquidity removed. As of today, we have witnessed 53 rate cuts and about $400 billion in liquidity injected into the financial system, with another $600 billion to be added through 2020 by the U.S. Federal Reserve and European Central Bank, according to a Bank of America report. We can debate ad nauseam the fundamentals of any asset class; the fact remains that as long as there is cheap liquidity being pumped into the system by central banks, risky assets will get inflated.
The oil market was in surplus this year, but with over-compliance and maintenance over the last few months it is more finely balanced today. Of course, if there is actually a recession in 2020, oil price can fall much further. But then so will all other asset classes, and that is what the central banks are trying to avoid.
It is a very bold move to suggest further oil output cuts going into the fourth quarter, which is when we start to see a pickup in seasonal demand spurred by heating oil. If the central banks are trying to jump-start the economy through cheap liquidity, then we might see a pickup in growth for right or wrong reasons.
U.S. shale oil has seen a massive growth spurt over the past few years, though its rate of change is slowing as seen in the drilling data. Taking all this together, we could be in the middle of the perfect storm for oil markets, where prices can rise aggressively in a very short period through the first quarter.
If the price of oil along with commodities and risky assets start rallying, the Aramco IPO by default also will do well along with the global energy sector. With each change of $1 per barrel in Brent oil's price, Aramco's cash flow increases by $1.5 billion; hence supporting the price of oil is of great importance.
The energy sector has been a laggard over the past few years given its perennial underperformance in capturing oil prices. If oil demand picks up at a time when supply is being curtailed, all stocks will rally aggressively, even Aramco. It will not be because it was cheap or priced at a discount, but it would benefit with the macro landscape. If this happens, central bankers would take credit for its success without realizing the irony and timing of it all, in the same way they are not able to see why oil prices fall when the macro slows down. International investors who stayed away from Aramco may miss the jump in the share price if oil's price rallies, but then again they could easily buy a basket of Oil super majors and exploration-and-production companies today to get the same benefit for their portfolio at a lower valuation and higher dividend yield.
The end result will be spun in many ways, with the average investor clueless, but one needs to remember that a rising tide does lift all boats.